What's Developing in Emerging Markets

Despite the strong returns of U.S. equity markets, it has been a different story for emerging markets. The MSCI Emerging Market Index, a proxy for emerging market equity returns, has fallen 9.94% so far this year through the end of August. In contrast, the S&P 500, a proxy for U.S. equity markets, has risen 16.15% in the same time period. Emerging markets are generally countries that are experiencing rapid growth and industrialization, but which have yet to prove sustainability of this prosperity. Characteristics of emerging markets generally include a growing middle class population, rising domestic consumption, lower consumer and federal indebtedness than developed countries, above average GDP growth, a focus on infrastructure development, and increasing business productivity and globalization.

TA number of factors have recently contributed to the loss of investor confidence in emerging markets as a whole. Economic hardship has given way to social unrest in several important regions such as Brazil, and media coverage of these events have exacerbated investor concern regarding these issues. Such press has drawn greater attention to the risks and growing pains associated with investing in emerging markets. Despite these recent concerns, we still believe the potential for growth and profit remains intact for these regions.

Why Have These Concerns Emerged Now?

Recently, concerns over the ramifications of U.S. monetary policy, the economic shift in China and its impact on global commodities and currencies, and deteriorating growth prospects throughout the region have spooked investors into exiting these markets in droves. However, unlike the developed world, which comprises markets that are more mature by economic and capital markets standards, emerging markets vary greatly in their stages of development. This disparity makes it imprudent to paint the entire region with a broad brush and creates significant opportunity for the discerning investor.

An intended consequence of the Fed's quantitative easing policies has resulted in U.S. dollars flooding into various bond markets, especially those in the emerging markets. Following news that the Fed may be reversing its stance, these flows began to reverse out of both bonds and currencies. This, along with China's decreased growth projections, has raised investors' concerns of another 1997 Asian Financial Crisis. However, emerging markets have changed greatly in the past 16 years. Relative to the past, they have better capital structures, improved balance sheets, and greater infrastructure. The deficits in trade and sovereign balance sheets which gave way to the 1997 crisis are no longer prevalent among emerging markets. Central banks around the world have exerted their influence and used their policy flexibility to better manage growth and maneuver through macroeconomic headwinds such as the debt crisis in Europe and slowing growth in China. Today, many emerging countries maintain stronger balance sheets than countries in the developed world, reporting lower federal and consumer indebtedness than developed markets. As such, we believe such parallels are not accurate and concerns are overblown.

Growth over the next decade is not expected to keep up with the breakneck pace we have seen in the past decade, but again, the entire region should not be viewed as a collective in this respect. There will continue to be great opportunities for investors to find growth for as long as these markets continue to develop, and we see recent market volatility as an opportunity for better managers to differentiate themselves from the pack.

Despite These Concerns, We Still Like Emerging Markets

There are four primary reasons that we continue to favor an allocation to emerging markets. A burgeoning middle class, governmental reform, globalization, and greater liquidity still form the foundation for protracted growth over the medium and longer terms that dwarfs the prospects found amongst economies in today's developed world. Emerging markets are home to almost 20% of Fortune 500 companies, 30% of the world's billionaires, and 15 of the world's largest cities. These markets account for over 80% of the worldwide growth in energy consumption over the last 10 years and are home to a disproportionate percentage of the world's population relative to energy consumption, exports and wealth. As these emerging market economies develop, energy consumption, exports and market cap will increase, providing many opportunities to profit from these foreseeable trends. Based on these reasons, we continue to favor an allocation to emerging markets in a diversified portfolio.

This information compiled by Cetera Financial Group is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment.

No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular news update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in indices. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security covered in this material may not be advisable or suitable. Please consult your financial professional for more information.

While diversification may help reduce volatility and risk, it does not guarantee future performance. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

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